Crowding externalities and optimal subsidies in public transport: Revisiting the Parry–Small model

Subsidising public transport is a widely used policy, normally justified by redistributional objectives. Frequent use of subsidies, however, does not mean uniformity, as the actual subsidy rate varies between countries and cities. Excessive subsidisation of public transport can also be criticised by the presence of externalities, most importantly on-board crowding. This paper revisits Parry & Small (2009), one of the most influential contributions in the recent history of public transport economics. Despite the popularity of the Parry–Small model, it neglects existing empirical evidence on the effects of crowding on passengers’ wellbeing. The purpose of the present study is to redesign and recalibrate their model by expressing crowding disutility as a multiplier of the value of in-vehicle travel time, and also to extend the analysis to the context of the Hungarian interurban transport system. Our results show that the crowding externality is a critical component of optimal pricing, as it decreases the optimal subsidy rate by 4 to 29%, even at a moderate level of capacity utilisation. This means that optimal fares are higher than they were previously found. We extend the original analysis to the case of Hungarian interurban transport and highlight the model’s sensitivity to the assumed substitution pattern.